Dishonour of post-dated cheques taken as security

By Amit Aggarwal and Rahul Sud, SNG & Partners
26 February 2017

Using a post-dated cheque (PDC) as a security for repayment of a loan is a common practice among lenders and financial institutions. An unresolved question is whether issuing a PDC for the satisfaction of debt and issuing a PDC as a security have similar or a different meaning under section 138 of the Negotiable Instruments Act, 1881, for the purposes of prosecution.

Amit Aggarwal Partner SNG & Partners
Amit Aggarwal
SNG & Partners

In the case of Sampelly Satyanarayana Rao v Indian Renewable Energy Development Agency Limited the Supreme Court recently considered whether the dishonour of a cheque, which was issued after a loan was advanced, was covered by section 138. The court held that if on the date of the cheque, the liability or debt exists or the amount has become legally recoverable, section 138 is attracted and not otherwise. The court further explained that whether a PDC is for the discharge of a debt/liability depends on the transaction.

The litmus test applied by the court was whether the PDC is for the discharge of an existing enforceable debt/liability or whether it represents advance payment without there being a subsisting debt/liability. The court held that the repayment becomes due under the agreement the moment the loan is advanced and the instalment falls due. Therefore, if a PDC is issued after the loan is advanced, it would attract section 138, as it would satisfy the criteria of existing debt at the time of issuance of the cheque.

The prerequisite for criminal liability under section 138 is that the cheque in question was issued in discharge of any debt due or other liability. If a PDC is issued as a collateral security, for instance where a blank PDC is issued prior to disbursement of a loan, no debt is due at the time of issuance of the PDC and consequently section 138 will not be applicable (Ramkrishna Urban Co-operative v Shri Rajendra Bhagchand Warma). Similarly, a PDC issued for advance payment for a purchase order cannot be considered as a PDC for discharge of debt (Indus Airways Private Limited v Magnum Aviation Private Limited).

The following decisions have also been based on this litmus test and illustrate applicability of section 138.

In ICDS Ltd v Beena Shabeer the Supreme Court held that the words “where any cheque” and “other liability” in section 138 clarify the legislative intent and that the liability of a guarantor under section 138 cannot be avoided when the cheque stands returned by the banker unpaid.

 Rahul Sud Associate partner SNG & Partners
Rahul Sud
Associate partner
SNG & Partners

In Krish International P Ltd & Ors v State & Anr the seller issued an undertaking giving a right of presentation of cheques to a factor if the buyer/principal debtor failed to make payment. Delhi High Court held that, prima facie, the cheques were issued towards the seller’s liability, which was co-extensive with the debtor’s liability.

In STP Ltd v Usha Paints and Decorators Karnataka High Court held that the distinction sought to be made between issuance of a cheque for repayment of debt and issuance of a cheque as a security for repayment of debt is illusory in law and any cheque if dishonoured would incur liability of prosecution under section 138.

In MS Narayana Menon (Mani) v State of Kerala and Anr the Supreme Court observed that if a cheque is issued for security or for any other purpose, it would not come within the purview of section 138. However, Karnataka High Court in M/S Shree Ganesh Steel Rolling v M/S Stcl Limited observed that this was a passing observation of the Supreme Court, which cannot be mechanically applied in all circumstances.

In Goa Handicrafts, Rural and Small v Samudra Ropes Pvt Ltd and Ors Bombay High Court held that a PDC, which was meant to be kept in safe custody and not for encashment, was a security and thus an offence under section 138 was not made out.

The judgment in the Sampelly case did not comprehensively lay down instances which could distinguish when it will be construed that a PDC has been issued as a security, as distinct from when it is issued for discharge of debt/liability. It also did not consider exhaustively the above-
mentioned judicial precedents, apart from Indus Airways, which it distinguished on facts. However, there is an important lesson for banks and financial institutions in the Sampelly case and that is to ensure that PDCs are always obtained as a condition subsequent to the disbursement and not as a condition precedent and more towards repayment of debt This will ensure that the liability or debt exists on the date of issuance of the PDC.

SNG & Partners has offices in Delhi, Mumbai, Singapore and Doha. Amit Aggarwal is a partner and Rahul Sud is an associate partner.